Introduction

The Cayman Islands Court of Appeal decision in In the matter
of the Herald Fund SPC (In Official Liquidation)1
has provided some clarity on the ranking of priority in liquidation
of amounts owing to shareholders and former shareholders of a
company operating as an open ended investment fund. In summary, if
a former shareholder has completed the redemption process
prescribed by the company's articles, s/he will be treated as a
creditor (although ranking behind the general body of outside
creditors). If a former shareholder has only "accrued the
right to redeem", in that the redemption process prescribed by
the company's articles has not been completed, then s/he will
be treated as a shareholder.

The issue

Herald Fund SPC had been a feeder fund for Bernard L Madoff
Investment Securities LLC prior to its collapse following Mr
Madoff's revelation that he had been conducting a massive
fraud.

The issue before the Court of Appeal was whether a redeemed
shareholder, who had completed the redemption process in accordance
with the company's articles of association but had not yet been
paid because of an intervening winding up, was to be treated as a
creditor or a shareholder for the purpose of the redeemed
shareholder's claim in the liquidation for the unpaid proceeds
of the redemption.

The legislative framework for share redemption and priority
ranking in liquidation

Section 37(7)(a) of the Cayman Islands Companies Law (2003
Revision) (the Companies Law)2
deals with redeemable shares in the context of a winding up of the
company and materially provides that:

"Where a company is being wound up and, at the
commencement of the winding up, any of its shares which are or
are liable to be redeemed have not been redeemed or which the
company has agreed to purchase have not been purchased, the
terms of redemption or purchase may be enforced against the
company, and when shares are redeemed or purchased under this
subsection they shall be treated as cancelled:

... this paragraph shall not apply if: i. The terms of
redemption or purchase provided for the redemption or purchase
to take place at a date later than the date of the commencement
of the winding up" (our emphasis).

Section 37(7)(b) then sets out the priority ranking of an amount
due under sub-section (a). In essence, it provides that these
amounts rank behind the company's debts generally but ahead of
amounts owing to members in satisfaction of their rights as
members.

Relevance

The Court of Appeal's decision brings some clarity to the
question of how amounts owing to former shareholders and existing
shareholders are treated in the winding up of a company that
operates as an open ended investment fund.

The Court of Appeal's decision has confirmed that section
37(7)(a) applies where a shareholder has merely "accrued the
right" to redeem his or her shares, but has not yet completed
the redemption process prescribed by the company's articles.
Such a shareholder would be still "redeeming" his/her
shares and not "redeemed". For those lucky (former)
shareholders who have fully redeemed, but have not yet been paid,
they are treated as creditors and section 37(7)(a) does not apply
to them.

The Court of Appeal accepted the argument that section 37(7)(a)
of the Companies Law was enacted to permit a claim by a
"redeeming" shareholder in a liquidation where no such
claim could be made under the general winding up provisions because
(firstly) the purported claimant would still be a shareholder and
(secondly) a counterparty is not usually permitted to enforce a
contract against a company in liquidation which requires the
company to pay out money in order to acquire property.

Conversely, the redeemed – but as yet unpaid –
former shareholder who is not impeded by these two considerations
has a provable claim in the liquidation as a creditor for the
redemption proceeds under section 139(1) of the Companies Law. In
this regard, the Court of Appeal held that the claim of the former
shareholder ranked behind the claims of ordinary creditors
(pursuant to section 49(g) of the Companies Law), although still
ahead of amounts owing to current shareholders. Section 49(g) of
the Companies Law provides that no amounts owing to a shareholder
"in his character of a member" are deemed a debt
of the company payable to the shareholder ahead of any amount owing
to an outside creditor.

The Court of Appeal reasoned that a claim for unpaid redemption
proceeds, being a claim founded on the statutory contract between a
member and the company, was a claim for an amount due in the former
shareholder's character as a member and so would fall within
the ambit of section 49(g) of the Companies Law.

In coming to its decision, Field JA of the Court of Appeal
expressly rejected the reasoning of the Eastern Caribbean Supreme
Court in the decision of Western Union International Limited v
Reserve International Liquidity Fund Limited [2010] ECSJ No 26
(Western Union) that considered section
197 of the BVI Insolvency Act 2003. In that decision, Bannister J
held that a claim for redemption proceeds in liquidation is not
founded on the statutory contract between a member and the company
because redemption is a surrender of membership and so a claim for
the proceeds of redemption, being consideration for the surrender,
could not be made in the former shareholder's
"character as a member" (being the threshold to
triggering the application of section 197 and relevantly the same
words used in section 49(g) of the Companies Law).

While Bannister J's decision was not reversed by an
appellate court3, the BVI Court of Appeal in
Westford Special Situations Fund Ltd v Barfield Nominees
Limited HCVAP 2010/014 disapproved Bannister J's
conclusions as to the characterisation of redemption proceeds (in
the context of whether a redeemed shareholder had standing as a
creditor to petition for the appointment of a liquidator to the
company) and so it is doubtful whether Western Union
remains good law in BVI, let alone of relevance to the Cayman
Islands.

Comment

Given that over 80 per cent of Cayman Islands open ended
investment funds are conducted through a company structure, it is
obviously highly desirable that the Companies Law be clear and
unambiguous as to how amounts owing to redeemed former shareholders
and redeeming existing shareholders be treated in the winding up of
a company. It is apparent, however, that section 37(7)(a) of the
Companies Law suffers from some unfortunate drafting, including the
absence of a definition for the term
"redemption".

The Court of Appeal's decision has clarified when section
37(7)(a) of the Companies Law applies and the concomitant priority
to be given in a company's winding up.

However, whether a (former) shareholder has been redeemed or
merely accrued the right to redeem pursuant to an interpretation of
the company's articles may still be something on which
reasonable minds may differ.

This is more likely to be an issue for articles of association
drafted before 2009. After the Cayman Islands Court of Appeal
decision in Re Strategic Turnaround [2008] CILR 447,
Cayman Islands funds practitioners tended to draft investment fund
articles of association to provide greater clarity that, (subject
to any powers to suspend redemptions) shares are automatically
deemed to be redeemed on the relevant redemption day and the
balance of the steps required before payment of the redemption
proceeds could be made (for example, calculation of the net asset
value) were not part of a process of "redemption" of the
shares. While this decision was reversed on appeal by the Judicial
Committee of the Privy Council, the Committee noted that the
relevant articles of association were unclear as to the point at
which redemption was deemed to have occurred. Accordingly, in order
to avoid any doubt, the practice developed as a result of the Court
of Appeal's decision in Re Strategic Turnaround has
continued.

The authors understand that the liquidator has appealed the
Court of Appeal's decision to the Judicial Committee of the
Privy Council.

Footnotes

1 Unreported, dated 19 July 2016

2 Section 37(7)(a) of the Companies Law (2013 Revision),
being the current revision, is in the same form as that section in
the 2003 Revision.

3 The authors understand that, while an appeal was made,
the parties agreed between themselves to reverse Bannister J's
decision and so an appellate judgment was not given.

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